Question

JO Electronics is considering two plans for raising $ 5 comma 000 comma 000 to expand operations. Plan A is to issue 6​% bonds​ payable, and plan B is to issue 200 comma 000 shares of common stock. Before any new​ financing, JO Electronics has net income of $ 400 comma 000 and 600 comma 000 shares of common stock outstanding. Management believes the company can use the new funds to earn additional income of $ 800 comma 000 before interest and taxes. The income tax rate is 40​%. Analyze the JO Electronics situation to determine which plan will result in higher earnings per share

Answer 1

Plan A results in higher EPS

Step-by-step explanation:

The bonds' issuance option would require that the company pays interest on the bonds.

Original eps =$400,000/600,000=$0.67

Interest on bonds=$5,000,000*6%=$300,000

Additional income $800,000

less interest expense ($300,000)

earnings before tax $500,000

tax at 40% ($200,000)

additional net income $300,000

new eps=($400,000+$300,000)/600,000=$1.17

EPS under the Plan B=$400,000+($800,000*(1-40%))/(600,000+200,000)

=$880000 /800,000=$1.10